Freelancing? Here are the best ways to stay in the tax man’s good books
As a freelance professional, you have made the decision to leave traditional employment and set up in business on your own account. Having made your initial lifestyle choice, there are various options available to you with regards to how you can work, which include, running your own limited company, operating on a sole trader basis or continuing on a payroll albeit not in a traditional employment relationship. Your own circumstances will determine which of these is most appropriate. In this article, we outline the choices and the various factors which might lead you to consider them.
In some markets, the most common way to find new customers is through a recruitment agency. If you work in one of these markets and you currently source your work via a recruitment agency, you can choose to work on a PAYE basis and effectively, you will be treated as employed by the agency for tax purposes. The agency will provide a payroll service and deduct income tax and national insurance on this basis. It will also ensure you have all the relevant insurances to enable the services to be supplied compliantly to the end client. As a freelancer working in this way it is simply a case of turn up and do your job.”
Again, if you tend to source work via a recruitment agency, another source of PAYE services is an umbrella company. These companies should be independent of the agency and see you as their customer so you can stay with them long-term even if your change agencies as your work progresses. In certain circumstances, although you will receive most of your income after deduction of PAYE and NIC, business expenses can be claimed tax free giving a financial benefit. You will be regarded as an employee of the umbrella company which should put the necessary insurances and employment contracts in place to enable the services to be provided. This route requires relatively minimal input from you as a freelancer and will generally suit those who do not wish to take on the responsibilities that come with running a business.
Setting up your own business
For those freelance professionals who would prefer to run their own business two further options exist. One is to work on a sole trader basis and the other is to run a limited company. The simplest of these in administrative terms is the sole trader route. As a sole trader, there is no corporate entity involved; all income and costs are seen as individual income and costs and taxed as such. There are fewer returns to submit each year when compared with running your own limited company.
As a sole trader you can claim income tax relief on a wide range of allowable business expenses, including travel and subsistence expenses. However, you are not protected by limited liability, unlike working through a limited company, and therefore ultimately can be held personally financially liable in the event of something going wrong.
Finally, and an important point to note, for those businesses who work through a recruitment agency rather than direct to a client, most are not prepared to engage freelancers on a sole trader basis because of the risk of HMRC considering the individual as a disguised employee and the agency being liable for underpaid PAYE and national insurance. Therefore this way of working tends to apply to those individuals who work with multiple clients and who source work directly”
Limited Company Working
As a self employed freelance professional you may choose to set up and run a limited company. As well as the increased risks and responsibilities there are some distinct advantages of operating a business in this way.
Limited liability protection means that if things go wrong, directors and shareholders have the protection that they are not personally liable for the debts of the company – providing of course that they have been operating compliantly.
As a director of a limited company you can choose to receive dividends and, as with sole trader operations, a wide range of business expenses can potentially be reimbursed tax free. Both of these can lead to a financial benefit.
Since the introduction of IR35 legislation by HMRC, it’s vital for freelance professionals in limited companies to be clear on employment status, otherwise you may have a substantial amount of additional tax to pay. If you fail to clarify your status and compliance with IR35, the subsequent investigation can prove time consuming and costly.
IR35 is tax legislation brought in to target ‘disguised employees’ who historically, were claiming both the tax benefits of working freelance, along with the benefits of being a company employee.
As a genuinely self employed individual you can still operate your own limited company and access the benefits that this way of working provides. However, you must be very careful in choosing the advisors that you use to support this way of working.
Running a limited company does come with significant responsibility and company administration. For example, the director and/or company secretary are responsible for ensuring that the limited company meets its obligations and is run in accordance with the Companies Act. The director must ensure the limited company complies with company law, accounts properly with full disclosure, makes all statutory returns, is adequately insured and meets all its health and safety obligations.
The complexity of these various regulations means that, as a freelance professional, you must ensure that you are using the right advisor to support your limited company.
Expert Help and Advice
Whichever way you choose to work it’s important to remain compliant. Consequently, it is essential to take professional advice every step of the way to thoroughly understand the pros and cons of the various approaches available.
The right option to choose will vary from individual to individual dependent upon your personal and professional circumstances. It is imperative that all freelance professionals take individual advice to understand which option is most appropriate for them, and the risks and responsibilities associated with each.
There is a plethora of organisations out there offering everything from accountancy services to legal support; however, we would always recommend going to a specialist in this industry that fully understands relevant legislation and the requirements of the individual. The cost of getting it wrong could prove to be very expensive indeed.
About the Author: Martin Hesketh is the managing director of Brookson, a leading tax and accountancy firm that provides financial services and support to freelance professionals who choose to set up and run their own business.